Dodd-Frank s Whistleblower Bounty Provisions: The First Wave of Tips Filed with the SEC and What Public Companies Should Do Now

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1 Dodd-Frank s Whistleblower Bounty Provisions: The First Wave of Tips Filed with the SEC and What Public Companies Should Do Now Mike Delikat, ORRICK (mdelikat@orrick.com; ) The Dodd-Frank Act provides powerful monetary incentives for whistleblowers to report securities and commodity law violations to the SEC and CFTC, as well as strong protections for doing so. Whistleblowers who provide the Commissions with original information about violations of securities or commodities laws will be awarded a share of between 10% and 30% of monetary sanctions ultimately imposed by the Commissions that exceed $1 million. The SEC has established an Office of the Whistleblower dedicated to receiving whistleblower tips, and has already received hundreds of tips about alleged securities law violations from all across the U.S. and around the world. And the SEC s whistleblower award chest is fully funded with U.S. $452,000,000 of taxpayer dollars. This article briefly summarizes Dodd-Frank s SEC whistleblower bounty provision, describes the first wave of tips that have been filed with the SEC, and offers best practices we are advising our clients to follow to reduce their ultimate monetary exposure from regulatory actions and litigation brought under Dodd-Frank. The SEC Bounty Provision The SEC sets a fairly strict standard for eligibility as a whistleblower under Dodd- Frank. To meet these requirements and be eligible for an award under the bounty provision, a whistleblower must: (1) voluntarily provide the Commission (2) with original information (3) that leads to the successful enforcement by the Commission of a federal court or administrative action (4) in which the Commission obtains monetary sanctions totaling more than $1,000,000. The SEC will also pay awards based on amounts collected in certain related actions, defined by the regulations as judicial or administrative actions brought by the U.S. Attorney General, an appropriate regulatory authority, a self-regulatory organization, or a state attorney general in a criminal case, which are based on the same original information that the whistleblower voluntarily provided to the Commission and that led the Commission to obtain monetary sanctions totaling more than $1,000,000. The SEC s Office of the Whistleblower and the First Wave of Tips The Dodd-Frank Act required the SEC to establish a separate office within the Commission to administer and enforce the Act s whistleblower provisions. The SEC s Office of

2 the Whistleblower is now fully up and running, processing hundreds of tips from whistleblowers in pursuit of multi-million dollar bounty awards. On November 16, 2011, the SEC's Office of the Whistleblower released its first annual report to Congress, as required by section 924(d) of the Act. The report only includes information about tips received after the final rules implementing the program became effective on August 12, As a result, it only includes seven weeks of data. Still, the information provides useful insights into the number and types of whistleblower complaints being received and some insights into the Office's activities to date. The Office's primary activities to date have included: Establishing a publicly-available whistleblower hotline for members of the public to call with questions about the program; Launching a website, which includes detailed information about the program, links to required forms, and a list of notices of covered actions for which whistleblowers may seek bounties; Meeting with whistleblowers and their counsel to provide guidance concerning expectations and follow-up; and Actively publicizing the whistleblower program through presentations, press releases and other public communications. The Office expects that, as the program evolves, it will provide individualized notice to whistleblowers who may have contributed to the success of a Commission action resulting in monetary sanctions exceeding $1 million, so that they can apply for bounties. Number and Types of Tips Received The Office reported that it received 334 tips between August 12, 2011 and September 30, This number is far below the SEC's previously publicized reports that it was receiving approximately 100 whistleblower tips a day, with an anticipated volume of 30,000 tips a year. The actual number received thus far suggests closer to a total of 2,500 tips a year if the tips continue at the same pace. The volume of tips will likely increase, however, after the first bounties begin to be awarded and the program becomes more widely publicized. As for the types of tips received, the most common complaint categories were market manipulation (16.2 percent), corporate disclosures and financial statements (15.3 percent) and offering fraud (15.6 percent). Foreign Corrupt Practices Act (FCPA) tips only comprised 3.9 percent of those received, somewhat surprising given the high level of government enforcement activity in this area. Location of Tips The Commission received whistleblower submissions from individuals in 37 states, as well as 11 foreign countries. The most highly represented states were California, New York, Florida and Texas. The most highly represented foreign countries were China and the U.K. In

3 the seven weeks for which data was compiled, whistleblower tips from foreign countries constituted approximately 10 percent of all tips received. These numbers reflect that it is critical for multinational companies that have not yet done so to review their whistleblower and ethics policies and procedures not only for the U.S., but globally, to determine whether changes are warranted under Dodd-Frank. Implications for Internal Reporting Perhaps the most controversial aspect of the SEC s bounty provisions is that they strongly incentivize employees to go directly to the SEC with concerns of violations rather than first reporting issues internally to the company to try to resolve them through internal compliance procedures. Many companies commenting on the SEC s proposed regulations urged that the SEC require internal reporting before a whistleblower could make disclosures to the SEC and be eligible for a whistleblower bounty. The SEC rejected such a requirement, and instead attempted through its final regulations to incentivize employees in three ways to use their companies internal compliance and reporting systems when appropriate. First, the regulations provide that a whistleblower who first reports possible violations of the law internally to the company and within 120 days reports the same information to the SEC could be an eligible whistleblower whose submission is measured as if it had been made at the earlier internal reporting date. Second, the regulations provide that if the employee reports internally, and the company then provides information arising out of that report to the SEC, the employee will be eligible for a bounty as the original source of all of the information the company provided to the SEC, meaning a potentially greater award. To qualify under this rule, the employee must report to the SEC within 120 days of reporting to the company. Third and finally, with respect to the criteria for determining the amount of an award, the regulations provide that a whistleblower s voluntary participation in an entity s internal compliance and reporting systems is a factor that can increase the amount of an award, and a whistleblower s interference with internal compliance and reporting is a factor that can decrease the amount of an award. Time will tell as to whether these so called incentives will achieve their stated objectives. Critics of the SEC s approach have argued that these efforts to incent employees pale in comparison to the powerful monetary motivations for employees to immediately secure their place in line at the SEC as the original source of information in quest of a potentially huge bounty award. In July, 2011, Congressman Michael Grimm introduced legislation to amend Dodd-Frank s whistleblower provisions to require internal reporting; however, there has been no action on the bill since it was sent to committee in August, Best Practices We have worked with a number of our clients to address the challenges of Dodd-Frank's whistleblower provisions. The following are best practices companies can engage in now to minimize their risks.

4 As an initial step, all companies should review their existing internal reporting and disclosure policies as well as policies against retaliation to encourage internal reporting as much as possible, and incorporate those obligations into other documents such as deferred compensation arrangements. The SEC s whistleblower program strongly incentivizes whistleblowers to go straight to the SEC to secure their place in line as the original source of information about violations. Companies who want the opportunity to address these issues before they are communicated to the SEC should encourage internal reporting as much as possible, but not impede employees from going straight to the Commission, which is prohibited by Dodd-Frank. One critical way to encourage internal reporting is to set the right tone at the top, by publicizing the existence of, and value of, internal reporting, through communications from the CEO or other senior management. There should also be multiple avenues of reporting to ensure that employees have an avenue through which they feel comfortable reporting. Second, companies should improve procedures and processes for receiving tips and promptly and thoroughly investigating them. Under Dodd-Frank, employees who report internally before going to the SEC must report to the SEC within 120 days of the internal report for the look-back provisions of the Act to apply, requiring quick and effective investigations. Companies should evaluate whether existing compliance and legal staff are adequate to meet the challenges of Dodd-Frank. Companies should also update the procedures and timelines for conducting investigations, and the documentation, where appropriate, of investigations and outcomes. In addition, companies should consider Board involvement in the review of whistleblower complaints. Training programs for supervisors are essential to ensure all levels of management are sensitive to comments from employees that might later be considered to have been Dodd-Frank whistleblower complaints, both to ensure that the concerns are investigated properly, and to ensure that the employees are not subjected to retaliation, which is explicitly prohibited by the Act. Finally, companies should review their third-party vendor agreements and practices (e.g., consultants, auditors, hotline administrators) to ensure they, too, provide optimal protection. Dodd-Frank whistleblowers are not limited to the company s own employees; rather, almost anyone who has knowledge of the company s practices may submit tips to the SEC and be potentially eligible for a bounty. Thus, it is critical for companies to review their vendor agreements and practices to ensure that they too encourage internal reporting of their employees, to reduce the likelihood that such employees will report highly confidential company information directly to the SEC without the company having the opportunity to address potential violations in the first instance. In light of the Dodd-Frank Act s drastic changes to the landscape of employee whistleblower incentives and protections, companies can expect to see an increase in the number of whistleblower complaints they receive, as well as increased SEC enforcement activity arising from insider whistleblower tips. This will particularly be so when the SEC begins awarding its first bounties and the program becomes more publicized. By taking the steps outlined above, companies can begin to ready themselves for the new wave of whistleblower complaints and minimize the risks associated with them.

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